The Outlook for 2010 in Commodities

by: Matthew Bradbard

Much like 2009 we expect 2010 to be more of a traders’ market as opposed to sitting in positions for extended periods. A successful trader will need to apply fundamental research and technical research by paying attention to seasonal tendencies, examining correlations commodity to commodity, monitoring the weather and most importantly being flexible with their positions. By this I mean to perhaps scale back your position size because of the volatility, trade both futures and options, and use hedging strategies. The two principal conditions to look out for this year are who wins the argument on inflation vs. no inflation and decoupling relationships between asset classes. To keep up to speed with our ideas we encourage investors to follow in our weekly commentary or daily blog.

The substantial swings we expect to see in 2010 commodity wise will force investors to be more attentive with their portfolios. Speculators, hedgers, and producers need to recognize that with this comes excellent opportunity but much more risk. While it is unlikely that we will encounter the same type of swings this year as the previous two, one will need to bring their best game to be successful at marketing, hedging, or speculating this calendar year. The good news is that more investors are trading commodities which are quickly becoming a critical component of the global economic system and a necessary asset in your portfolio.

We are looking forward to 2010 and see many opportunities that we’ll outline here. For further explanation and to keep up on an evolving basis follow our Weekly commentaries and on our blog’s Daily thought at Feel free to visit and give us feedback, we are always eager to see what other traders and investors are doing.

Agriculture: Corn is a global market so one needs to pay attention to the global picture and with world ending stocks projected near four decade lows, even with a massive US crop, supplies are tight and it will not take much for corn to get moving higher again. In 09’ US farmers planted an estimated 86.5 million acres and early projections are for 90/91 million acres to be planted in 10’ we may need to see higher prices to buy acres. Perhaps the biggest wildcard will be the dollar which has a grave impact on exports. After about a 10-15% correction from the most recent USDA report we suggest buying and looking for prices to get back to at least the previous resistance levels. Currently, clients are being advised to buy May and July call options or December futures.

Soybeans are transitioning from 2 straight years of tight ending stocks, but with a large jump in crop size domestically, even with a late harvest and prospects of a sizeable crop in South America, we expect to see a jump in world ending stocks. The wildcard is the growing appetite for soybeans from China and if their domestic usage continues to grow, will it out strip the jump in ending stocks? Assuming the near record yields forecasted by the USDA are accurate and South America does there part, the world stocks/usage ratio should make its way back to 06/07, levels when beans were 30-45% cheaper. So many variables could lay the groundwork for wild swings in the soybean complex in 2010. A trade down to $8/bushel is not out of the question while we expect the lows to be made in Q1 and then a grind higher with a high range forecast of $13/bushel. For the time being the price of soybean meal may move somewhat lower, but with the dramatic increase year over year in consumption levels we will be looking for long opportunities once a low is established early this year. We see no reason not to see a trade back over $375/400 in 2010. To help navigate soybean oil, traders should pay attention not only to soybeans but also Crude oil, as we’ve noticed a correlation over the years. What makes this market interesting is the increased participation of index funds in this market. Once this trend gets moving north again a trade back near 50 is probable, which is a 33% appreciation from the front month contract currently. The world wheat market experienced scattered weather problems in 2009 but this paled in comparison to the global issues we encountered the previous year that helped lift prices to record highs. While we expect nothing of the sort in 2010 a weakening dollar the second half of 2010 could have a serious impact on exports and help the wheat market find a solid base; we cannot see prices getting below $4.25-4.50. Wheat may be one of the most sensitive agriculture markets to food inflation so on increased fears make sure you are playing from the long side. Recent action in wheat has not really allowed us to trade on behalf of clients either direction so we’ve been trading KCBOT against CBOT. We may continue to suggest buying KCBOT against CBOT wheat whenever it is trading at a discounted price. We do expect prices to trade back over $7/bushel in KCBOT and CBOT wheat but at this time I’m not sure if it will be late 2010 or 2011.

Softs: 2010 like 2009 we want to suggest that ignoring this sector will not benefit one financially.We again suggest you start paying attention as these 5 markets offer profound opportunities. Sugar was one of the standouts last year as a world deficit helped contribute to prices trading to multi-decade highs. With both India and Brazil the two top producing countries in the world having supply issues this move may have legs. A stock to usage ratio is projected at just under 16%; which would be the lowest in 26 years. Prices may seem high but those who study history recognize that prices in the 80’s reached 45 cents and in the 70’s prices traded near 60 cents. We have clients positioned in May call spreads anticipating a trade over 31 cents/lb and possibly higher and also have positions in calendar spreads trying to capitalize on the deeply backward dated conditions.

Coffee experienced two sided trades last year and looking back was for the most part in a 20/25 cent range. The trend line dating back to last summer comes in just above $1.35 which we expect to hold and on the upside could see prices trade above $1.50 and potentially make their way to $1.70. We start the year with relatively tight stocks, but perhaps bigger factors will be weather in South America, global demand and the direction of the dollar.

Cocoa like sugar was a top performer last year carrying prices to 28 year highs on weather concerns, problems in growing areas, increasing demand for chocolate, increased fund activity and lastly dollar weakness. To start the year we feel this market may be a good candidate for a short and have started to price our bearish plays for May and July. We do not expect prices to exceed $3500 and if so by a very negligible amount, if we get even a 38.2% Fibonacci retracement of last year’s move that takes prices back below $3000.

Cotton looks to expand upon the 50% appreciation we saw in 09’ but the wildcard in 2010 will be to see an improvement in demand. In 09’ smaller supplies were the driving force and that can only carry prices so far. The USDA’s total cotton usage projection is at a 24-yr low so cotton will be guided not by consumption domestically but globally. We would like to buy a dip in this market but do not know how deep it could be. At this point we would most likely start testing the waters in longs for clients closer to 65 cents. There seems to be formidable resistance at the 76 cent level but on a trade above that level we cannot rule out 80 cents. Looking at historic monthly charts back 20 years prices have traded above 90 cents in 6 different years so who knows?

After a near freeze in Florida lifted prices to 2–yr highs this could just be the beginning of what OJ has to offer in 2010. Per capita OJ consumption is close to multi-decade lows and when you throw into the mix a smaller than previously expected citrus crop it may not take much to get a bullish environment. Prices have doubled in the last 12 months so we may be a bit ahead of ourselves but after the correction that is currently under way that should take prices down near $1.05/1.15 we may look to re-gain long exposure. If able to get long near those levels we would use upside targets of $1.30, $1.50 and then $1.70.

Metals: Copper is not a market you can put a position on and forget about as swings have just become too large. Prices in the last 4 years have been under $1 and over $4. Off their lows which were established in late 08’ early 09’, prices have rocketed higher by almost 270%. At this point we say prices are too high and we would expect a set back; a trade back to $2.40- 2.60 is not out of the question. The demand out of China was one of the main driving factors in 09’ and if we were to see that pace slow one would expect a correction to ensue so pay close attention to copper earmarked to China this year. Copper continues to act as a very accurate barometer on global economic sentiment and if prices are either extreme or moving higher or lower at a swift pace do not ignore the warning signs.

Gold saw record highs last year trading over $1220/ounce but after a wash out early this year we would expect new record highs. Before we would expect that to really develop we would anticipate the masses to get out of the trade and for this trade to be far less crowded. As we hinted at last year, when the markets are leaning only one way the ensuing move is generally in the opposite direction. Though we feel gold has and will continue to serve as a store for value, we expect the move higher in 2010 largely to be driven by more investors realizing that we have inflation around the corner. The 50 day moving average comes in just below $1000/ounce and at about that level serves as a 38.2% Fibonacci retracement level so that would make sense for a back off point. The closer we get to that level or if we even get below that the level, the lower one is able to buy gold and the more bullish we are. On the upside we are expecting to see a print very close to $1400/ounce this year.

Silver outperformed gold in 09’ and we expect the same outcome in this calendar year. Silver failed to get back to its highs reached in early 08’ while gold hit fresh record highs, so in my eyes silver has some catching up to do. Furthermore, the gold/silver ratio that you need to be aware of as a metals trader we view to be way too wide. This spread has decreased from the wide level we saw in late 08’ of 85:1, but at the current level the spread is still at 61:1 when historically it has been closer to 30:1. The 50 day moving average in silver comes in just above $15 and though we think a loss of 18% from the current level may be a stretch, we would maintain a buy the dips mentality in silver with a price objective on the upside of $22-24 in 2010. In both gold and silver we would suggest buying the dips we see the first part of the year because if things go as planned we may not see those levels again this year. Additionally we would suggest scaling into the trades and utilizing a combination of futures and options as we expect volatility to persist.

Energies: We expect a significantly smaller trading range in 2010 than we experienced in 2009 with prices trading at a high over $80/barrel and a low just above $30/barrel. In 2010 we do not expect a humdrum market and oil traders must be prepared for volatility, we anticipate more sideways action as opposed to the solid up trend we saw last year. On the low end we expect the band to come in between $60-65/barrel and on the upper end a band between $90-95/barrel. We cannot rule out a triple digit trade but it would take either a brutally cold winter, active hurricane season, serious Middle –East conflict or a collapsing US dollar. Energy traders cannot ignore how low the refinery utilization rates have been for the last several months. US refiners have cut back their operations to trim back oversupply thus allowing crude stocks to rebuild. We will continue to navigate this market from both sides feeling there will be enough movement to make money both long and short oil in 2010. Additionally, we would suggest using spread strategies and a combination of futures and options to trade oil as out right plays in futures and options can be pricey and too risky in our eyes. With RBOB prices collapsing last year the refineries made a few decisions that will impact prices in 2010. As daily production declines were noted, what went largely ignored was that demand started to begin drawing down gasoline stocks causing prices to move higher. Off their 2009 lows RBOB prices appreciated over 150%. I guess this was expected BUT prices have yet to make their way back to their highs that we saw at the pump and we feel it may just be a matter of time. A trade back to $1.50- 1.60 would be a gift for those looking to get long though we think a trade below $1.75 is unlikely; on the upside we see $2.35- 2.50. In the energy complex in 2009 heating oil was the straggler and though we did experience wild swings, the bullishness in Crude oil and RBOB largely overshadowed this market. It could be a different story this year as we did fall to multi-decade lows on heating oil stocks and so far this winter has been chilly. Much like RBOB the price will be influenced by how long the refinery operating rates stay at depressed levels. You really cannot blame refiners either as margins have not been favorable so why ramp up production if it is not cost effective. On the low end we feel $1.65–1.75 should support and see that on an upside extension prices could make their way to $2.55- 2.65. To review on these three markets pay attention to weather, driving habits, refinery utilization rates, consecutive weekly draws or builds in inventory and finally the direction of the dollar. In 2009 it was oil that led the distillates higher or lower but what could make 2010 a bit different is that the products could have a larger influence on the overall path of oil.

Natural gas may have reached an extreme low late last year trading near $2.50; the lowest level in 7 years. Clearly any commodity trading below the cost of production prices do not stay there for lengthy periods regardless of their circumstances. Looking at the big picture, seeing the rig count down with the expected policy shift towards using more natural gas in the national supply chain, we think the path of least resistance should be up. That is not to say we are buyers here, in fact we expect prices to re-visit $5 and then we would be looking for long opportunities for clients. We see an absolute bottom in 2010 at $4.50 and could expect a trade back near $7 if industrial demand was to resurface.

Currencies: The media has painted a picture that the dollar is doomed but their timing may be off saying the dollar’s status as the reserve currency is in question being we only experienced 5% depreciation last year. The trend is down and this is undeniable, but unless the US is the only country that keeps rates low and ALL the Central banks globally raise interest rates the dollar will be here…well at least through 2010. We do expect the lows around 72 to be challenged and we could see a new low but an entire meltdown to us is not likely. Let’s get one thing straight, the US preaching a strong dollar policy is lucrative and as we’ve voiced for years, action speaks louder than words. Like in 2009 currency action in 2010 will all be relative. In other words rates should start moving higher in most of the developed countries with currency traders paying attention to the spreads. Increased government support is not out of the question though it is not likely. Let me restate it would not be prudent! As for predictions on other crosses we expect the commodity currencies to come off in Q1 as we get a temporary dollar appreciation and commodity correction and then for the Kiwi, Loonie and Aussie to be a buy and make their way to fresh highs. We see the trading ranges as follows: the Kiwi .6500-.8000, the Loonie.9000-1.03 and the Aussie .8400 - .9600. We do not see the Euro trading above $1.50 and think it’s likely to see a test of $1.25 either late 2010 if not early 2011. The Swissie should follow the Euro lower and although we may get a temporary lift above $1.00 early this year, we feel a move back to the mid .80’s is likely.

The Japanese yen should continue to gain if equities fall apart though rates are effectively at 0% in Japan low interest rates could continue to fuel the carry trade. If excessive risk taking was to reappear, which we think is likely, the unwinding of this spread could lift prices to multi-year highs. The yen is a tough call and it could see massive moves either way because if investors draw in their horns and refrain from taking risks we could see a collapse back to levels not seen since 2008. The dog of the group we feel is the Cable and much like the second half of 09’ we will continue to have a sell rallies mentality with clients in the British Pound. We feel $1.7000 will serve as solid resistance and expect to see prices make their way back near $1.4000 by year’s end.

Financials: While there are consequences if a large institution tries to move the Equity market and it is frowned upon when Central banks intervene in the currency market, I presume that when the government manipulates the bond markets we are supposed to turn a blind eye. That is what the story was in 2009 as we feel that the government controlled the flow and moved the Treasury market higher and lower as it saw fit. What should be the driving force in this market this year, is the perceived direction of interest rates and the eventual tightening which we expect to start around mid-year.The Fed may want to leave rates low for an extended period but when countries around the globe raise their rates the US cannot let the spreads widen significantly or it will suffer dreadful consequences. If we are right on stocks moving lower the flow of money may keep prices of Treasuries afloat temporally early in the year, but we suggest a short bias in Treasuries in 2010 as we expect more downside than upside potential. We see a trading range in 30-yr bonds of 124’00 to 108’00 and in 10-yr notes of 123’00 to 110’00. More than likely most of our trade recommendations in the Treasury complex will be the short end of the curve as opposed to the long end as we will be positioning clients in long dated put options and short futures in Euro-dollars to take advantage of the coming interest rate tightening. We made a similar prediction last year and hindsight tells us we were early but we continue to think risk/reward this is one of the best trades one may see in a lifetime. Let’s get real where can interest rates go from here? The key is to scale into positions and not add any substantial size until the market proves you right. We think once the Fed starts raising rates this trade could last 2-3 years. The key will be to stay with the trade, recognize this trade is not glamorous but if rates move to 7.5%-10% in the coming years this trade should reap hefty rewards. I should have known as the S&P bottomed in March 09’ at “666” that there was an uncharacteristic move to follow. The 50% appreciation got many investors back some money that was well deserved but what we should take away from a move like no other is we may be facing a crisis like no other. This should serve as a warning much like a loud horn before a devastating crash. By no stretch of the imagination do we think we’ve seen the worst; with growing unemployment, another leg down in real estate, the lack of consumer spending, mounting US debt, the rising cost of commodities and a rise in interest rates to come we Do NOT see the light at the end of the tunnel. Early this year we could see an attempt at 1175/1200 in the S&P, 11000/11250 in the Dow and 1950/2000 in the NASDAQ but we expect a sizeable correction to follow. Are we calling for a double dip, not at this point, but our downside targets are as follows: 825/875 in the S&P and 8000/8500 in the Dow, and 1400 in the NASDAQ. This market will continue be a stock pickers market and the days of buying and holding are dead. With still so many unanswered questions it is extremely difficult to predict what the right move may be. As investors we are in unchartered waters and making up the rules as we go.

Livestock: I guess when people are losing their jobs and homes their desire to eat beef diminishes, as the economy ballooned last year the demand for beef vanished. That was the story in 09’ which we expect to be the contrary in 10’ as inventories of cattle have shrank and though the per capita beef consumption is way down what if we see an increase in demand with the slack supplies, this could mean a monumental shift in the trend. The USDA shows a decline in production from the 2nd to the 3rd quarter for the first time since 1996. Off their lows in 96’ cattle prices appreciated 37% higher and being that we think the recent lows in live cattle made in late 09’ should be the low, a similar move could carry prices well over $1.00. Past performance is not indicative of future results. We currently have clients positioned long June futures with put option protection but as for longer term position traders a play in August may be more suitable. Most commodity markets bottomed early in the spring last year but hogs still felt considerable pain and did not bottom until August when prices traded near 43 cents. This was two fold with a total collapse in demand due to the strains on the economy and then the market had to deal with the “H1N1” outbreak. While there was no correlation between the disease and lean hogs the psychological impacts were felt in pricing. Since then prices have reversed and catapulted higher recently trading to near 70 cents and 8 month highs. On the weekly chart you can see a gap was filled from last April and being we never got the customary end of the year give back we have clients positioned short April expecting prices to come down slightly. After a moderate correction we suggest using the corrective break as a buying opportunity as long as the trend line holds which currently comes in around 64/65 cents on the continuation chart.

Conclusion: We have out lined a number of opportunities that we expect to see in commodities within the next few months to quarters. Even when times are dire, significant opportunities will present themselves where the risk to reward dynamic makes sense. The key will be identifying the inherent risk that you are comfortable taking. This market does not lend itself to simply buying and holding but will be more of a traders market.

The test of time has shown that commodities have tended to be one of the best performing asset classes during times of inflation. We have given a variety of trade ideas and I am imagining some may agree but many may disagree with our assessments; but this is what makes a market. Swim against the tide. Do things differently than others because remember most people lose money and if you do the same as most you will lose money too.

It’s too early to determine if the current decoupling of crude oil and the greenback and their overall influence on the other markets is just temporary. However, it is likely that the very strong correlation between crude oil and the value of the US dollar that occurred over the last two years has at least diminished, and that such a strong correlation will not play out in 2010. To take it a step further as a rising tide lifted all boats (i.e. asset classes) last year we do not expect this to be the case this year. Therefore equities should trade on their own, treasuries will be influenced by investor’s appetite for risk, foreign debt demand and on interest rates, the currency market will be impacted on interest rate fluctuations, and lastly we expect commodities to trade on supply and demand. Perhaps a bias because commodities are what we trade we think that as more investors figure out inflation is all but inevitable, money will pour into commodities from agriculture to metals from livestock to energies.

We’re suggesting that the individual commodity markets could finally start to focus more on their own supply-and-demand fundamentals, instead of mostly ignoring them and just looking to crude oil and the US dollar for the lead. Though 2009 was a very impressive year for commodities I think too many investors are discounting the potential of 2010. Commodities are quickly becoming a sustainable asset class as we see it moving forward while tough acts to follow a number of commodities still have significant upside potential. Years from now we will know but there is a good chance that the lows we made in late 2008 and into 2009 may serve as a turning point in some markets and it will take many years to revisit those levels. That is not to say all commodities will move higher and that it will be like shooting fish in a barrel. In fact we think the opposite; traders need to be even more selective when choosing their exposure. I’m certain some commodity charts will look like sharks teeth where there will be a number of corrections but as a whole we find more reasons to be bullish on most commodities as opposed to bearish.

Never in history have we had a global concerted effort to rescue the world financial systems and because of the course of action taken we sense markets are on the precipous of major inflation. Commodities are not a market that have turned bullish over night and not simply by government action but rather the years of underinvestment and the phenomenal growth in population. It all boils down to ECONOMICS 101 and supply and demand. Trade accordingly!

Risk Disclosure: The risk of loss in trading commodity futures and options can be substantial. Past performance is no guarantee of future trading results.